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The Fed Effect: Factors Influencing the Markets

The markets have been influenced by a number of factors lately, so it is only fair to highlight a sizeable quantity of charts to explain. The transition from a central bank driven to an earnings driven market has commenced, and the performance has been uninspiring. Revenues have consistently come in weak, which can be expected in an environment as is seen today. Domestic GDP did not disappoint, but it is not at point that it can meaningfully diminish unemployment. Europe is still a mess, a more organized mess, but a mess nonetheless. The farther we move from the date of the QE3 announcement, the closer we come to the election and impending "Fiscal Cliff." Both of these events incite volatility and keep market advances to a minimum. The central bank "put" is still in effect, limiting downside, but with a lack of upside momentum, sideways movement looks to be the tone.

Below is a chart of commodities (DBC) over intermediate treasury notes (IEF). This indicator advanced and spiked leading up to the announcement of worldwide easing, but has since done nothing. It has broken its trend, and maintains sideways action. The inherent weakness is a sign that easing has capped our losses, but will not do enough to create sustainable belief and risk sentiment.

Sticking with the commodities theme, the next indicator is gold (GLD) over intermediate treasuries. Gold has traded in stride with risk assets lately, and this indicator has had an especially strong correlation. Gold showed consolidation after the Fed announcement, but failed to sustain strength upon reaching its apex. The indicator has trended lower as of late, and has broken major MA support lines. This weakness will weigh on markets and foreign currency appreciation for the time being.

Turning to domestic equity, the capital flow between equity (SPY) and bonds is under the microscope. After peaking in mid September, this indicator has drifted sideways for a number of weeks now. It sits at its lower end currently, and will need to find a source of strength or prepare for broader pullbacks in equity and risk. The soft revenues are not helping, and misses by Apple (AAPL) and other heavy hitters have weighed markets down. Uncertainty should keep this indicator range bound and even deliver slight dips below its pattern.

Another Fed indicator is seen in the bond markets. Inflation protected securities (TIP) and long term treasury bonds (TLT) paint a picture of the inflation expectation in markets. This indicator correlates nicely with risk assets and is quickly approaching its apex. It spiked in September, along with most risk assets, and now looks for a new direction over the following weeks. A sharp rise in either direction will have a strong influence on market sentiment and the direction of markets throughout Q4.

The last aspect of equity markets is the indicator of dividend funds (DVY) over broader equity markets. Capital usually flows to dividend paying stocks when market direction is uncertain and investors are choosing more defensive plays. This dividend fund has outperformed since QE3, and shows no sign of impending weakness. The strong negative correlation makes it a good indicator to track the VIX (VXX) as well. Volatility is expected with the upcoming election and "Fiscal Cliff," so do not be surprised to see this indicator stick to its trend.

Foreign markets play a large part in influencing asset movements as well, and maybe none bigger than the future of the Euro (FXE). The Euro has vastly outperformed US treasuries, which is a good indicator of capital flow between regions. The Euro being a risk trade has caught a consistent bid for a better part of three months. The indicator has reverted back towards its trend line recently with speculation around both Greece and Spanish outcomes, but there has not been a substantial break as of yet. Look for the movement of this indicator over the next few weeks to guide markets.

The last indicator is a testament to central bank easing over the past few months. Developed market equities have struggled in this post QE3 announcement world, but emerging market equity (EEM) looks to be outperforming world equities (VT). This indicator is primed for a breakout to the upside. This may not mean that all equities are set to spike due to renewed sentiment, but the amount of capital flow into emerging economies may fuel their respective equity appreciation over the following weeks. It is pertinent to have a clear tactical thesis when navigating in uncertain markets. Whether this be long or short positions, projecting where capital is going next means the difference between profits and losses.

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